Second Half 2021

 

Considering the strong returns in the first half of 2021, we will provide our thoughts on the second half. Obviously, we cannot predict the markets; however, we can use some statistical analysis to shape a thesis and probabilities. Usually, market strength begets strength and most of the studies confirm this. That is bullish for the second half of the year. We will look at two studies: one that confirms that bias and one that differs. For a bullish tone, a study by one of our favorites, Ryan Detrick, shows that when the S&P 500 is up greater than 12.5% year to date at the end of June, the next six months are up a median of 9.7% which is twice the median final six months for all years.

 

If we want to pump the breaks on optimism, we know that the third quarter is the most challenging during the year with August and September being some of the worst trading months. A recent study from Nautilus Capital provides a contrast to the recent strong upside momentum presented above, writing “#SP500 first half year to date momentum "IS" typically a good indication of continuing rest of year momentum (no revelation there as many technicians; including us monitor this closely.) In contrast, the study below offers an interesting "twist" on potentially excess momentum....”   

This study certainly paints a different picture than the normal strength begets strength argument. Another study shows the one-year rolling correlation of the Nasdaq 100 against the ten-year treasury yield. This is simply another valuation metric that shows that the index is historically extended. The question is whether the future is based on the 2000 and 2007 precedent or more like the mid-90s and 2017-time frame. Clearly the outcomes are incredibly different with the former leading to devastating bear markets and the later just a continuation of a secular bull market.

 

 

As we look to the second half, the most important consideration from a macro stance will be the direction of interest rates and yields. The language from the Fed will determine most of that action and their decision to taper, raise rates, or do nothing will be the most important discussion. Every statement or comment will be combed through in fine detail looking for the smallest of nuances. Yet, after a tough first half for growth equities, we could see a sustained rotation out of value and back into growth if rates subside. A recent tweet from Jurrien Timmer sums this up, “with peak reopening and peak inflation likely behind us, I expect some ongoing counter rotation from growth stocks.”

We expect the inflation debate will continue in the back half of the year. Additionally, there will be ruminations about the pace of economic growth, which is certain to decelerate from the torrid pace seen in the first half of the year. The Fed will be central as they attempt to shift policy and dance around concerns over peak growth, Delta variant, and inflation.

We still believe the market remains in a secular bull market and the future remains very bright for growth equities as the technological revolution continues even after a tough first half. As active managers, our smaller size allows us the flexibility to change our exposure levels with more ease, which is critical for extracting alpha for our partners. We believe our methodology protects our partners’ capital through various cycles.

2nd Quarter Review

Stocks looked tired in the 2nd quarter as they fought off challenges on a number of fronts.

The continued preoccupation with the Federal Reserve's potential timing of interest rate hikes was only one of several concerns.  First, coming into the quarter, investors once again worried about the economy being on shaky ground as the 1st quarter saw GDP contract due to a variety of other factors including terrible weather.  However, as Q2 moved on we saw signs of the economy firming as the weather improved, the employment market picked up and housing appeared to steady.  This led to some speculation that the Fed could act to raise rates as early as June.  However, Chair Yellen and co. cited the year's early economic weakness as a reason to not yet move but also rearranged some of the language in their statements.  While they have certainly left the door open for an initial hike later in 2015, it's now clear they will be very deliberate with regard to the pacing of subsequent hikes.

As the quarter moved on, Europe came back into focus.  While a number of its economies and markets appeared to benefitting from the European Central Bank's latest quantitative easing efforts, Greece's debt problems became more and more of a concern until ultimately coming to a head in the last week of the quarter.

All of this news helped to keep the majority of US stocks in the incredibly narrow range in which they've traded for most of the year.  The S&P 500 and Russell 2000 finished essentially flat for the quarter while the Nasdaq was able to post an admirable 1.75% gain.

On a year to date basis, the story is similar for the S&P as it finished the first half of the year almost exactly where it started.  Meanwhile, the Russell 2000 and Nasdaq have continued to maintain pole position in the 2015 relative strength race.

On a sector basis, health care, cyclicals and financials lead the way in Q2 while utilities, energy and industrials held the broader market back.

And it's pretty much the same story when expanded to a year to date view with health care and cyclicals being the clear leaders to the upside while energy and utilities lag well behind.

Looking internationally, the Chinese markets have gone on a heck of a ride so far in 2015. The Shanghai stock exchange roared higher during the 2nd quarter until peaking on June 12th.  While still up handsomely on the year, the index has tumbled nearly 25% over the last 3 weeks.  Similarly, Russian stocks have logged impressive gains so far in 2015.  Predictably, Greek stocks have struggled majorly as the country/economy has fallen into a depression.

Looking outside of stocks, long-dated bonds and commodities have lagged mightily on the year.  The TLT (iShares 20-year treasury) is down more than 5% in 2015 on the back of rising rate worries.  While the overall commodities complex has been severely weighed down by the plunge in oil/energy prices earlier in the year.  Elsewhere, short-maturity bonds and municipals, while not logging gains, have at least managed to stay afloat.  And though the US Dollar has come off its highs it's still generated a healthy year to date return.

On to the 2nd half....

1st Quarter Review

The 1st quarter came and went in a flash and it's time to look back to see what worked and what didn't.  The hope is to find the themes that shaped the winners and losers in order to see if we can extract any actionable ideas from the data.  The patterns observed are, in part, what shaped the money flow in the market and ultimately determined what asset classes made money in the first quarter.  We track a variety of sectors, countries, and major macro classes.

Looking at developed markets, the clear winner in the first quarter was Europe along with the Shanghai index.  However, if you weren't currency hedged you dramatically underperformed domestic investors because of the weakness in the Euro during the quarter.  A great illustration is to compare the US listed German ETF (EWG) versus the iShares Currency hedged MSCI German Index (HEWG).  You can see how the hedged index rose at a much faster rate than the un-hedged EWG.

Meanwhile, US index's were laggards as they finished flat to slightly positive.  Digging deeper, strength was seen in smaller caps while growth outpaced value.

From a sector standpoint the winners vs. laggards was striking.  Strength was seen all quarter in healthcare while utilities were a constant drag.  The weakness in utilities continues the interest rate theme and shows how the threat of higher rates can impact the market.  Healthcare continues to benefit from the enormous rise in biotech valuations and activity.



From a macro asset class standpoint, the dollar stood out among all the winners.  Another interesting story was that given all the persistent worry about rising interest rates, bonds prices continued to hold firm as yields have fallen since year end.   If you guessed the biggest loser was the Euro considering the dollar strength you would be almost right.  It was the 2nd most significant loser we follow behind oil.   The ratio chart below comparing the dollar to oil shows a heck of a story.  Starting last summer these two asset classes have moved in near perfect opposition.

The emergence of Europe as a leader in Q1 was a direct correlation to the fresh round of quantitative easing they've recently embarked on.  Considering the US's history of QE and how it positively moved asset classes, this could have a prolonged affect on European risk assets.

Here's a look at where some of the more widely followed benchmarks and ETFs stood at quarter end.